Earnings Transcript for STCN - Q1 Fiscal Year 2011

Operator: Hello, and welcome to the ModusLink Global Solutions first quarter fiscal 2011 conference call. At the company’s request, this conference is being recorded. Please note that all lines will be in a listen-only mode until the question-and-answer portion of today’s conference call. (Operator instructions) Now I would like to turn the call over to Mr. Joseph Lawler, Chairman, President and CEO; and to Mr. Steven Crane, Chief Financial Officer. Please go ahead, Mr. Crane.

Steven Crane: Thanks, Felicia. Good afternoon, everyone, and thank you for joining us for ModusLink Global Solutions fiscal 2011 first quarter conference call. I’m Steve Crane, CFO, and I’m joined today by Joe Lawler, Chairman, President and CEO. In just a few moments, Joe will share his thoughts and the company’s financial performance and the market environment over the past quarter and provide an update on our strategic initiatives. After Joe’s comments, I will review in more detail our fiscal 2011 first quarter results, which we released earlier today. Before we start, I want to remind you that this call is being broadcast as a live webcast from our website at www.moduslink.com. Please also note that the information we’re about to discuss includes forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Such statements involve risks and uncertainties. The company’s actual results could differ materially from those discussed herein. Factors that could contribute to such differences include, but are not limited to, those items noted and included in the company’s SEC filings, including our annual report on Form 10-K and quarterly reports on Form 10-Q. The forward-looking information that is provided by the company in this call represents the company’s outlook as of today, and we do not undertake any obligation to update forward-looking statements made by us. Subsequent events and developments may cause the company’s outlook to change. During this call, we will be referring to non-GAAP measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP measure can be found in our earnings release issued earlier today, a copy of which is posted in the Investors section of our website. I’d now like to turn this call over to Joe Lawler. After our formal remarks, we’ll be happy to take your questions. Joe?

Joseph Lawler: Thank you, Steve, and good afternoon. I will begin with a few brief comments regarding our first quarter before Steve provides a more detailed financial overview. First, as we entered the new fiscal year in August, we continued to see the effects of clients being very cautious and focused on reducing costs in their supply chain programs, which I’ll talk about more in a moment. However, overall results for the first quarter were in line with our expectations and we saw some encouraging signs. In particular, revenue from new client programs increased 49% compared with the first quarter of last year as a result of our sales and marketing initiatives. In addition, we continue to aggressively manage expenses resulting in an improved cost structure and leverage to support future profitability. Overall, revenue for the first quarter was consistent with our expectations and reflective of lower revenue from base business, which consisted programs we’ve been executing for 12 months or more and significantly higher revenue from new programs compared with the first quarter of last year. New program revenue consists of programs we’ve been executing for less than 12 months. Within revenue from base business, we’ve seen seasonal increases in some client programs although they have not been widespread as unit volumes varied significantly from program to program and region to region. In addition for several quarters, we’ve talked about the effects on our business from price pressure and reduced form factor where our clients use less packaging and materials in their products. These factors are normal in our business, but have been accelerated in the current environment and were reflected in our first quarter financial results. We see our clients operating very cautiously and very focused on reducing costs in the supply chain. We managed this challenge with innovative solutions that enable clients to meet their cost objectives while maintaining a price discipline that will enable us to achieve a good return on our investment over the long-term. Regarding new business, we are encouraged with our progress in growing revenue from new programs as we work to build back to the record levels achieved in fiscal 2009. As I noted, revenue from new programs increased 49% compared with the same period last year. New business in the first quarter was from programs secured from existing and new logos in recent quarters, which are now generating revenue. We are also encouraged with the size and quality of opportunities in our pipeline and the progress we’ve been making in its development. Gross margin in the first quarter was 9.5% and expectedly lower than what we reported during the first quarter fiscal 2010. Primary drivers were unfavorable revenue mix and pricing, including the one-time effects of a price concession made with a client that has a significant program with ModusLink, which we’ve talked about last quarter. During our last investor call, you’ve heard us talk about these factors as having an anticipated effect on gross margin during the first quarter. As we move forward, we expect that gross margins will improve from first quarter levels based on our cost actions, a more favorable revenue mix, and the one-time item I mentioned will be behind us. While gross margins will fluctuate from quarter to quarter in the future, we continue to regard our target of 12% to 14% as an appropriate range for gross margin on an annual basis, including for fiscal 2011. In addition, we continue to execute our selling, general and administrative cost reduction programs. Excluding SG&A from our Tech for Less business unit, which was acquired last December and is not present in the year-ago quarter, total SG&A was 8% lower year-over-year, primarily due to our cost reduction and expense management activities. I’ll make some additional comments about our progress driving new revenue and our ongoing strategy in a few minutes. But before I do, Steve will give you a more complete financial overview.

Steven Crane: Thanks, Joe. For the first quarter of fiscal 2011, ModusLink Global Solutions reported net revenue of $236.4 million, a decrease of $10.3 million or 4.2% compared to net revenue of $246.7 million for the same period one year ago. Of that $10.3 million decline, foreign exchange accounted for approximately $4 million. Base business revenue was $207.6 million, a decrease of $19.7 million or 8.7% compared to the first quarter of last year. Within base business revenues are contributions of $9.7 million from Tech for Less, which was acquired on December 4, 2009. Revenue from new programs was $28.7 million, an increase of $9.4 million or 48.6% when compared to the first quarter of last year. As Joe noted, this expected increase was a result of new programs acquired in previous quarters and that are now generating revenue. Geographically, revenue in the Americas increased 1.3% to $80.8 million compared to $79.8 million in the same quarter of 2010. The startup of new programs as well as increased volumes in our base business a positive impact on our revenue in the Americas. Revenue in Europe decreased 3.1% to $77.7 million compared to $80.2 million in the same quarter last year, primarily due to foreign exchange. Revenue in Asia decreased 22.6% to $57.5 million from $74.2 million in the first quarter of fiscal 2010. Revenue in Asia was affected by lower volumes from certain programs, pricing and the other factors we described today. ModusLink’s gross margin decreased to $22.4 million or 9.5% of revenue in the first quarter of fiscal 2011 from $36.0 million or 14.6% of revenue in the first quarter of fiscal 2010. Gross margin for the first quarter was lower primarily due to revenue mix and pricing, as Joe noted. For example, our results in Asia include the price concession, which we’ve talked about last quarter, which had a one-time impact of $4 million to revenue, gross margin, operating income, and cash flow in the first quarter of fiscal 2011. We expect our gross margins to continue to be impacted by the drivers that influenced our first quarter results. However, as Joe mentioned, as we move forward, we expect that gross margins will improve from the first quarter levels primarily based on cost actions, a more favorable revenue mix, and the fact that the one-time item I mentioned will be behind us. Total SG&A, excluding restructuring, for the first quarter of fiscal 2011 was $22.6 million compared to $23.0 million in the first quarter of the previous year. Please note also that the prior year period did not include operating cost related to Tech for Less, which accounted for $1.3 million of the $22.6 million in SG&A expenses in the current year quarter. Excluding the SG&A from Tech for Less, total SG&A would have been 8% lower year-over-year, primarily due to our cost reduction and expense management activities. Restructuring expense for the first quarter of 2011 was $789,000, primarily related to our cost reduction initiatives compared to an expense of $129,000 in the first quarter of fiscal 2010. As we have noted in the past, in a normalized environment, our expectation is that annual restructuring expenses would be in the range of $2 million to $4 million. For the first quarter of fiscal 2011 and as a result of what I discussed, the company recorded an operating loss of $2.7 million compared to operating income of $11.6 million in the first quarter of fiscal 2010. Other expense for the first quarter of 2011 was $2.7 million compared to an expense of $1.2 million in the first quarter of fiscal year 2010. This increase in expense was primarily due to higher foreign exchange transaction losses in the first quarter of fiscal 2011 and the impairment of an investment in the @Ventures portfolio. The company recorded a tax expense of $1.3 million for the quarter, an improvement of $600,000 compared to the first quarter of fiscal 2010. We continue to evolve and drive our tax strategy to both support our business strategy and to maximize the use of our US NOLs. With all the above factors for the first quarter of fiscal 2011, ModusLink reported a net loss of $6.7 million or $0.15 per share compared to net income of $8.6 million or $0.19 per share in the first quarter of fiscal 2010. Our balance sheet continues to be strong. As of October 31, 2010, the company had working capital of approximately $224.1 million compared to $222.6 million at July 31, 2010 and $248.9 million at October 31, 2009. Included in working capital as of October 31, 2010 were cash, cash equivalents, and marketable securities totaling $146.2 million compared to $161.6 million at July 31, 2010 and $174.7 million at October 31, 2009. The company concluded the quarter with no outstanding bank debt. Turning to cash flow for the first quarter of fiscal 2011, net cash used for operating activities was $15.6 million compared to a use of $1.3 million in the same period in fiscal year 2010. Cash used for operating activities in the first quarter of fiscal 2011 was affected by seasonal working capital needs. As investors that have been following us now, in our fiscal first quarter, we usually have higher working capital needs, as ModusLink and its clients prepare for the higher volumes around the holidays. As a result of this increase, we typically report a net use of cash during our first fiscal quarter and generate cash in our second fiscal quarter. Given the normal patterns in our business, we encourage our investors to look at our cash flow on an annual basis. During the first quarter, we’ve repurchased approximately $1.4 million worth of shares of ModusLink common stock as part of our previously announced $10 million stock buyback program. This latest repurchase brings our total stock buyback investment to $56.7 million since we first initiated a stock buyback program in early fiscal 2008. In total, we have purchased 5.8 million of stock, which is about 12% for the fully diluted outstanding share count at the time we announced the first program. We are committed to enhancing shareholder value, and we view a balance of a share repurchase program, investing in the business, and improving financial performance as the best means of creating long-term and lasting shareholder value. As announced in October, ModusLink plans to increase its capital distribution program by $40 million, inclusive of the remaining $6.6 million in the current stock repurchase program subject to the fiduciary duties of the Board of Directors. The Board will evaluate the most appropriate method and timing of the plans to capital distribution, which would commence in the first quarter of calendar 2011. Looking forward, during fiscal 2011, the company expects that its clients will remain cautious about managing their supply chains given the general uncertainties surrounding consumer spending and the company expects to experience similar economic-related factors that influenced its financial performance in recent quarters. For the second quarter of fiscal 2011, the company expects a single digit percentage decline in revenue compared to the first quarter of fiscal 2011, which is consistent with the seasonal pattern the company has experienced in recent years. The company is encouraged by the progress it is making to increase revenue from new programs and expects it will continue to show year-over-year improvement in revenue from new programs in the second quarter. Thank you and I’ll now turn it back to Joe.

Joseph Lawler: Thanks, Steve. As we move forward, we are focused on executing our long-term strategy. I’ll take a few more minutes to talk about some of our priorities to position ModusLink for revenue growth and effectively managing our costs. Developing new programs with existing and new clients continues to be a top priority for us. We have a differentiated and highly compelling value proposition that helps clients manage major supply chain challenges such as reducing costs and effectively managing the increasing complexity the global companies face to reach customers around the world. Our level of activity developing new business remains good, and our progress has been supported by changes we made to our sales organization in the recent quarters, such as realigning the reporting structure of our sales teams and organizing dedicated sales teams for each of our primarily solutions to enable a more targeted go-to-market approach. However, clients remain very cautious and sales cycles continue to be relatively long. Looking forward, we are pleased with the size and quality of the opportunities in our pipeline, which is stronger than last year. Our pipeline is comprised of good opportunities across our solutions, including high margin areas such as aftermarket and e-business solutions. It also includes prospective programs from clients who typically in-source supply chain processes. For example, in recent quarters, we secured several new programs from clients that have historically only in-sourced their supply chain processes, including the forward supply chain program for Sony Memory products in EMEA, which I described last quarter. We’re focused on opportunities with new and existing clients where our capabilities and investments will produce a strong return on our investment. Our second priority focuses on delivering excellent customer service and innovative solutions that provide real value to our clients. We recently won an award from National Instruments for providing a high level of client service. National Instruments is one of the leading providers of software and hardware solutions for engineering and scientific applications, and ModusLink provides sourcing and fulfillment of accessory kits with documentation and software for their customers in Europe and the United States. ModusLink is one of the largest Microsoft authorized replicators globally, which enables us to perform these services for companies like National Instruments. In addition, we are very proud that nine of the top ten companies featured in the industry analyst firm Gartner’s 2010 report of the top-performing high-tech supply chains are ModusLink clients. We’ve been recognized for our innovative services and are pleased to have won for the second consecutive year Supply & Demand Chain Executive's Green Supply Chain Award for helping our clients achieve their sustainability objectives. Sustainability is a significant opportunity for ModusLink, as more major brands embrace sustainability initiatives that have economic benefit. Many of you have read the increasing amount of sustainability reports being published by companies you might be investing in. Through ModusLink’s suite of sustainable value chain solutions, we improve our clients’ global supply chain procedures through sustainable packaging design, greenhouse gas footprinting, networking optimization, e-scrap, and repair services and value recovery. Our commitment to providing innovative services has also been the driver behind developing our aftermarket and e-business suite. Through our e-business solutions, we provide clients with a comprehensive set of integrated solutions from web store development and hosting to customer support, financial transaction management fulfillment, and post sales services. This is a high-value solution that places us close to our clients’ customers open the opportunities for higher growth and higher margin programs. Our aftermarket solutions manage the complete range of post sales activity for technology companies, including returns management, product repair, and asset recovery. We’ve been particularly challenged in the re-marketing area with an increased amount of competition for the resale of open box and high quality refurbished technology in consumer electronics goods. However, in aftermarket solution that includes integrated returns, repair and recovery services, is highly strategic and differentiating. We’re pleased to count the globe’s largest retailer as a client for our aftermarket services. We support them by providing returns management and other post sales services for TV, cameras and smartphones. While our aftermarket and e-business solutions are a relatively small part of our business today at less than 20% of our total annual revenue, their strategic growth initiatives aimed at improving the mix of services we provide to clients to position ModusLink for improved profitability in the future. We are seeing our clients value the range of services we provide, and approximately one-third of our clients are using more than one of ModusLink solutions, with several using each of our supply chain aftermarket services and e-business solutions. For example, we count one of the world’s largest networking product companies as a longstanding ModusLink client. We’ve been working with them to bring their whole networking products and video products to market through forward supply chain services across all three of our primary regions. We recently expanded our engagement with this client to provide support for their enterprise products and also added aftermarket solutions and e-business programs. We provide the client with testing and refurbishment services for their consumer products, and through our e-business solutions, we help manage returns through web portal management, financial transaction support, and reporting services. This is a good example why we are developing complementary solutions, how our solutions integrate in a client program, and how having integrated solutions can open across selling opportunities. Another priority centers on reducing and managing costs. We continue to look for opportunities to reduce cost and apply our continuous improvement processes in every part of our organization. Currently, 98% of our employees are trained on ModusLink’s continuous improvement process, resulting in high efficiency in each of our facilities. We continue to make progress reducing costs, which creates increased leverage in our model. Before we open the call to any questions you may have, I’d like to just briefly summarize why we remain enthusiastic about the future of ModusLink. First, we continue to have a very strong value proposition for a global marketplace where supply chain efficiency and time-to-market are becoming increasingly important. Second, we have an outstanding client list of blue chip Fortune 1000 companies. Third, our pipeline of new opportunities is strong and well represented by existing and new clients, and we saw momentum building new program revenue in the first quarter as a result of our sales and marketing focus. And fourth, we have a strong balance sheet that is a strategic differentiator and provides a platform for long-term growth. So with that said, I look forward to speaking with you again on our next earnings call. Now Steve and I are happy to answer any questions you may have. So, Felicia, if you would open it up for questions?

Operator: (Operator instructions) Your first question comes from the line of William Martin with Raging Capital.

William Martin: Good afternoon, guys. How are you?

Steven Crane: Good, Bill.

Joseph Lawler: Hi, Bill. How are you?

William Martin: Good. Just a question regarding the 12% to 14% target for this year, which you thought you could do this year, is that pro forma for the $4 million hit in Q1 or is that included in that?

Steven Crane: Bill, our comments were that it would be included in that. So, as we look out, we’ve often said, as you know, that the target model for this on an annual basis is 12% to 14%. So we feel that that can be achieved in FY ’11 as well.

William Martin: That’s great. Can you maybe outline some of the steps you are taking to achieve that?

Steven Crane: It’s things that I think we mentioned. It’s – in terms of cost control, it’s going to be – we expect a program shift and where it comes from as we move into the year. So it’s going to be increased revenues on some of the higher margin businesses that we referred to in the past. So it’s going to be a – there is a number of building blocks that are going to get us there.

William Martin: Got it. And the new business that you generated over the last two quarters, do you think that’s a good proxy for where we are moving forward or do you think we can get back to that $40 million to $50 million quarterly run rate that we saw in ’07 and early ’08?

Joseph Lawler: As we referred to, Bill, we are trying to build back to that record level of revenue that we saw just before the economic challenges of fiscal ’09 and ’10. And we certainly think we can get back to much higher levels of new business. It’s going to take us a little while because of the selling cycle, but we’re very encouraged about the progress made over the past couple of quarters and remain optimistic about the new business pipeline and some of the good things that are going on in that regard.

William Martin: What kind of quarterly run rate do you think you need to hit a tipping point where the overall business can start growing again regarding new sales?

Joseph Lawler: Well, as Steve commented, this particular quarter rate, we saw 4% decline. About half or 40% of that was foreign exchange. So we obviously need a little more new business in view of that base business softness. But what you’ve got is you’ve got a couple of factors that are working – that have been recently working against one another. So base business, continued base business softness with some increasing new business. So if we had perfect foresight on what was going to happen to base business, Bill, I think I can give you a much more accurate answer to that. As you know, when we’ve talked in the past, factors like price concessions, factors like form factors, factors like changes in programs from our base business tend to affect how that base business works. And so our – what we’re working to do is crank up that new business significantly higher than where we are today.

William Martin: Got it. And when you talked about revenue guidance Q1 to Q2, down single digits is a pretty wide margin. And I think last year you were down in the 4% to 5% range, which was “pretty typical seasonality” for you. Do you think it’s typical this year or are there other factors in play there quarter-over-quarter?

Steven Crane: Bill, I’ll take that one. I think it’s typical. I think you’re absolutely right to point out that Q1 to Q2 declined last year by just under 5%. The year before, it declined by just over 10%. So that’s what we’re saying, kind of look at those results over the last couple of years and it gives you some sense of where we probably expect the revenues to come in Q2.

William Martin: Got it. And just one more question. I appreciate your time. Just looking at Asia, traditionally that’s really been the strong point of profitability for the business by geography. It was really – it has been weak the last couple quarters. Can you maybe talk about what’s going on there? Are there client losses? What do we have to do to fix that?

Joseph Lawler: Couple of comments on that. I think – we are serving our clients over there extraordinarily well. That continues to be just a terrific area of execution for our business. The clients that we serve had seen some softness in their business, which they are focused on fixing, and we will continue to support them while they do that. We started the quarter out – actually started a little softer than we thought and saw things sort of build back as the quarter went on. So, a little more seasonal dip than we expected in the month of August and I think seemed to stabilize a little bit in September, October. But it’s really a function of our clients and the work that they are doing to penetrate their markets over there. We’ll continue to support them. We’ve mentioned that we’re expanding in the region. I think that it’s going to take a few quarters to really start to get the benefits of that in the future. But that was one of the things that we talked about associated with the $4 million investment that we made in the first quarter that we’re continuing to support expansion program with clients that we think have really good growth opportunities in the future there.

William Martin: But you do need a client behavior to change and you need more new business to change what we’ve seen over the last couple quarters there.

Joseph Lawler: Yes. Yes, certainly. Certainly.

William Martin: All right. Thanks, guys.

Joseph Lawler: Yes.

William Martin: Appreciate your hard work and your time.

Joseph Lawler: Thanks, Bill.

Operator: (Operator instructions) Your next question comes from the line of Matt Spiegel with Evermore Global.

Matt Spiegel: Hi. Thanks for taking my call. When you mentioned the 49% increase in revenues from new program, what are the levels that are being compared?

Joseph Lawler: Let me take – this is Joe. Let me take a first cut at that and Steve may want to put a little more precision around it. But basically what we call base business and new business, as I mentioned, base business is business that we’ve been executing for 12 months or longer, and new business program is a piece of business that we’ve started up and have been executing for 12 months or less. So what we’re doing when we make our comparison to new business in the first quarter, we’re comparing new business that we were executing for less than 12 months in our first quarter last year compared to new business that we’ve been executing for less than 12 months in our first quarter this year. And that’s where the 49% increase comes from.

Matt Spiegel: I see. What were those levels?

Steven Crane: Matt, in Q1 of ’10, the absolute levels were, new business was $19.3 million, and in this period, it was $28.7 million.

Matt Spiegel: Okay, great. Thank you. And my last question is just kind of – I know that you mentioned in the call the seasonality that makes working capital fluctuate. In steady state, if there is one, how much cash do you need to run the business?

Steven Crane: We often get that next question, and the way that we think about it in line of all of the global needs and some of the challenges we have of getting cash out of places like China, our expectation is that we will need $70 million to $80 million of cash to be able to fund our normal working capital. And it can shift and move about depending on if we get a number of new programs that are started up in any one particular quarter, back-to-back quarters. But that’s a good proxy for it.

Matt Spiegel: And does that include the amount that's committed to the @Ventures business?

Steven Crane: The amount that’s committed, we’ve invested – we had committed $50 million back in fiscal 2004. We’ve spent about $36 million of that. And we’re not planning on putting any real new investments into that other than to help keep our positions in some of our existing investments, kind of (inaudible) at certain levels that we don’t want to get diluted below.

Joseph Lawler: Let me just add – I'd add to that, Matt, we actually don’t have a committed capital fund. Every investment that we’ve made and every follow-on that we consider making is proposed by an individual that oversees @Ventures for us. It makes a recommendation to the Tech Committee of our Board, and the Tech Committee of the Board brings that recommendation to the full Board. So there is no – there is actually no committed capital going forward. We have publicly said that we will make no new investments in anymore portfolio companies and will only support those in which we feel that there is a terrific return for shareholders, and it leads us to a path of being able to get to liquidity as quickly as possible.

Matt Spiegel: Thanks.

Joseph Lawler: Yes.

Operator: (Operator instructions) Your next question comes from the line of Sam Klatt.

Sam Klatt: Hi. Is it possible to break out the performance of the underlying businesses on a top line and also bottom line as opposed to just seeing it by the region?

Steven Crane: Yes. That’s a good question. Right now, we’ve got the segments in a way that we have been reporting them. We’re looking at that to see if there is another of breaking them out along the lines of the operating units. But right now, we just – we don’t do that other than broken up Tech for Less because it’s a new acquisition. So we don’t at this point.

Sam Klatt: Is it possible to talk about it in an anecdotal way?

Steven Crane: If you could ask questions about –

Sam Klatt: Just to see trends, that would be helpful.

Joseph Lawler: Generally, Sam, what we’ve talked about in the past is, as we said today, the combination of our e-business and aftermarket services businesses represent less than 20% of our revenues. We’ve invested in them because for the reasons that we’ve commented on for a while is that we believe they offer higher margin potential, good strong returns on investment for the long-term, need to build all of these to real scalable businesses. But they are of strategic importance to us to help us improve the margins and long-term return on investment for the company. So each of the businesses that we referred to is e-business; our PTS business acquisition, which tends to focus on returns management and repair activities; and our GFL acquisition, which focuses on recovery; those investments have been made because of the long-term potential to help improve margins for us.

Sam Klatt: Okay. Thank you.

Joseph Lawler: Okay.

Operator: (Operator instructions)

Joseph Lawler: Okay.

Operator: At this time, there are no further questions.

Joseph Lawler: Good. Thank you very much to all of you for joining the call today. We look forward to talking to you the next time. Thanks, Felicia, you can end the call.

Operator: This concludes today’s conference call. You may now disconnect.